Striking the wrong shareholder chord

The chickens are coming home to roost on the federal government’s executive pay legislation, as it becomes increasingly evident that it has created a new destabilising force in the corporate landscape which is entirely removed from its purported intent.

Even before they were passed, many observers cautioned that these laws –and especially the so-called “two strikes" rule forcing boards to face a spill motion after two successive 25 per cent “no" votes on the remuneration report – would impact beyond their supposed target of curbing excessive executive pay.

It was obvious that a mechanism that allowed boards to be put in this position on the basis of a minority vote (in practice, often less than 10 per cent of the register) had potential to be misused, and abused, by shareholders with ulterior motives.

In some cases it could be used as a protest vote for grievances about company performance entirely unrelated to executive pay. Vested interests with a barrow to push can use it as a vehicle to attack boards on environmental, social or other issues.

It provides minority shareholders seeking to impose their will on a company against board resistance, and who have failed to persuade the majority of shareholders through other means, with an inappropriate mechanism to put pressure on the board. The latest AGM season, the first in which a “second strike" could be delivered, has demonstrated that two strikes is being used for purposes which have nothing to do with pay.

Examples have included Nathan Tinkler’s ultimately unsuccessful use of the rule to remove the Whitehaven Coal board, as well as Gina Reinhart’s attack on the Fairfax Media board, via support for a first strike vote on the remuneration report, as part of her campaign to gain a board seat.

Penrice Soda – which received a second strike despite its executives having had their base pay frozen for the last two years – is another case.

London City Equities, Penrice’s largest shareholder with 4.9 per cent of the company, had tried for several years to get a seat on the board and was repeatedly denied, including calling an EGM to depose two directors but losing the ensuing shareholder vote. While its concerns related to the company’s poor performance and low share price, not remuneration, the two strikes mechanism allowed it to succeed where these other avenues had failed, forcing Penrice directors to vacate their seats and stand for election.

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Another example of the legislation being used as a weapon in unrelated corporate battles is Globe International. Minority shareholders Solomon Lew and investment bank Kidder Williams, who hold 5.9 per cent and 2.3 per cent respectively, voted against Globe’s remuneration report, delivering a second strike and a board spill. This, they said, was prompted by the company’s poor performance and their long-running disagreement with its strategy.

Despite holding only just over 8 per cent of the company, they and another 4 per cent of the register were able to deliver a seemingly overwhelming 73.9 per cent “no" vote. Why? Because Globe chief executive Matthew Hill and his brothers Peter and Stephen, who collectively hold a 67.8 per cent stake, were unable to vote their shares on the remuneration report (as it concerned their own salaries) and another 16 per cent of shares were not voted.

Some say this problem is not widespread, or it’s a price worth paying for the additional engagement between boards and shareholders which they say two strikes has prompted.

It is true that in the latest AGM season only 14 companies received a second strike and only three – Penrice, Globe and Rey Resources – lost the subsequent spill motion and now face an EGM board vote.

But let’s be clear: a board spill is one of the most significant corporate governance actions that can occur. It can be very destabilising and value destroying for shareholders. It is an expensive exercise even if it does not eventually result in all directors actually being voted off.

This “stalking horse effect" is a serious policy flaw which must be addressed.

Getting rid of the whole misguided two strikes mechanism linking remuneration to a board spill would be the best option. However, lifting the strike threshold to the 50 per cent that applies for all other AGM votes, or requiring a no vote of 25 per cent of issued shares, rather than shares voted, would go some way to fixing the problem. The government must act to correct this perverse unintended consequence which effectively disenfranchises the majority of shareholders and is having a negative impact in ways completely divorced from the original aim of its legislation.